Insight Enterprises Inc (NSIT) 2013 Q3 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by, and welcome to the Insight Enterprises, Incorporated's Third Quarter 2013 Earnings Conference Call.

(Operator Instructions)

As a reminder, today's conference is being recorded.

It's now my pleasure to turn the floor over to Glynis Bryan.

Ma'am, the floor is yours.

Thank you.

Welcome, everyone, and thank you for joining the Insight Enterprises' conference call.

Today we will be discussing the Company's operating results for the quarter ended September 30, 2013.

I'm Glynis Bryan, Chief Financial Officer of Insight, and joining me is Ken Lamneck, President and Chief Executive Officer.

If you do not have a copy of the earnings release that was posted this afternoon and filed with the Securities and Exchange Commission on Form 8-K, you will find it on our website at Insight.com under Investor Relations section.

Today's call, including the question-and-answer period, is being webcast live and can be accessed by the Investor Relations page of our website at Insight.com.

An archived copy of the conference call will be available approximately two hours after completion of the call and will remain on our website for a limited time.

This call and the associated webcast contain time-sensitive information that is accurate only as of today, October 30, 2013.

This call is the property of Insight Enterprises.

Any redistribution, retransmission, or rebroadcast of this call in any form without the express written consent of Insight Enterprises is strictly prohibited.

In today's conference call, we will refer to a few non-GAAP financial measures as we discuss the third quarter 2013 financial results.

You will find a reconciliation of these non-GAAP measures to our actual GAAP results posted on our website on the Investor Relations page.

Finally, let me remind you about forward-looking statements that will be made on today's call.

All forward-looking statements that are made in this conference call are subject to risks and uncertainties that could cause our actual results to differ materially.

These risks are discussed in today's press release and in greater detail on our annual report on Form 10-K for the year ended December 31, 2012.

With that, I will now turn the call over to Ken to give you an overview of our third quarter 2013 operating results.

Ken?

Thank you, Glynis.

Hello, everyone.

Thank you for joining us today to discuss our third quarter 2013 operating results.

In the third quarter, we saw mixed results across our operating segments.

In North America, we saw better sales execution and improved profitability and believe that recent investments and the operational discipline we have been driving are beginning to show in our results.

We're disappointed [with] the financial results of EMEA and are highly focused on improving our performance in this segment over the coming quarters.

For the third quarter of 2013, gross profit increased 1% and gross margin expanded 50 basis points to 14.7%.

Consolidated net sales were down 3% year to year to $1.15 billion.

SG&A increased 3%, and earnings from operations excluding severances [claims], decreased 8% to $28.7 million.

On a GAAP basis, earnings from operations decreased 14% to $26.3 million.

Within these results, the North America business delivered improved results in the third quarter as (inaudible) top-line performance was more than offset by a focus on profitability.

Net sales declined 1% year over year while gross profit grew 5% and gross margin was very strong at 14.3%, up 80 basis points over last year.

We saw gross margins expand across all categories.

Our team executed well in the third quarter by optimizing funding and programs with our strategic partners.

This was achieved through disciplined program management and selling more complex solutions, expanding our software sales, and delivering double-digit growth and fees earned in software enterprise agreements, and improving the profitability of our services category with solid execution, expansion of higher margin service offerings.

We've been working actively in North America throughout 2013 to get a solid foundation in place for growth.

We're pleased that the leadership team is now in place and our execution is improving in key focus areas and the market's stabilizing.

Hardware and software booking trends have been strong so far in October, and we expect this segment will deliver both top line and earnings growth year over year in the fourth quarter.

In EMEA, net sales declined 6% in constant currency in the third quarter.

We continue to see weakness in our mid-market business and lower spending for software products by public sector clients.

Over the past several quarters, we have been taking actions to reduce our operating costs in this region and are beginning to see the benefits.

We've also completed the rollout of our new IT system and expect productivity improvement over the coming quarters.

However, our UK business is significantly under performing due to soft market conditions, weak sales execution, and systems integration challenges affecting productivity.

We believe it will take a few quarters to return to year-over-year earnings growth in EMEA.

And, finally, I'm pleased to announce the appointment of Wolfgang Ebermann as the new president of our EMEA operating segment effective January 6, 2014.

A 25-year industry veteran, Wolfgang brings -- joins us from Microsoft, where he most recently held the position of Vice President and Chief Operating Officer of Central Eastern Europe.

He has an established history of driving operational excellence and delivering growth in the mid-market and enterprise space across a multi-country footprint.

Wolfgang's leadership style and experience will undoubtedly help define/grow our competitive position in EMEA in 2014 and beyond.

In Asia-Pacific, net sales decreased 11% in constant currency, reflecting weaker sales in the mid-market and public sector.

Gross profit and earnings from operations also declined year over year in APAC due primarily to (inaudible) and program changes and lower product sales volume in the quarter.

One last update.

As we mentioned at our last conference call, our largest software partner's changed its channel incentive program beginning in October of 2013.

The changes vary in substance and time and across those partner's offerings.

Some of these changes are effective immediately and some will become effective as client contracts renew under their stated terms over the next few years.

We continue to analyze the program changes related to our portfolio of contracts and currently believe that we will see between $15 million and $20 million less in incentives from this partner in 2014.

We're working to take the necessary strategic steps to preserve our profitability and hope to offset this adverse effect of these changes with new business and cost reductions in 2014.

I'll now hand the call over to Glynis, who will discuss third quarter 2013 financial results in more detail.

Glynis?

Thank you, Ken.

In North America, net sales were $868 million in the third quarter, down 1% year over year.

Hardware sales declined 5% year over year but increased 3% sequentially.

By client group year over year, we saw double-digit increase in earnings in state and local markets in the US, offset by continued softness and spending by large clients.

In the software category, net sales declined 9% year over year due to particularly strong sales of business productivity products to US federal government clients and higher sales of software enterprise agreements in the commercial space.

While these services -- and while service's sales increased 5%, services' gross profit improved nicely -- I'm sorry -- while these services' sales decreased 5%, services' gross profit improved nicely in this third quarter compared to the same period last year.

Overall, gross profit in North America increased 5% year over year to $123 million.

Gross margin increased 80 basis points to 14.3% due primarily to the effect of increased vendor funding earned from certain strategic partners and increasing fees from enterprise agreements and higher services gross profit year over year.

These increases were partly offset by the effect of lower hardware sales volume in the period.

Selling and administrative expenses for North America in the third quarter increased $5.3 million year over year to $93 million.

The increase year to year is primarily due to increased headcount expenses of approximately $1 million, higher health benefit claims of about $900,000, and higher legal and professional fees of approximately $3.4 million year over year.

Please recall that in last year's third quarter, we received reimbursement of $2 million in legal fees that we had incurred in prior periods.

And in this year's third quarter, we incurred project-specific professional fees that were not recurring to [2014] and beyond.

We also recorded $530,000 in severance and restructuring expenses in North America in the third quarter compared to [$916,000] in the same period last year.

On a non-GAAP basis, excluding severance expense in both periods, earnings from operations in North America increased 2% year over year to $29.9 million in the third quarter.

On a GAAP basis, earnings from operations were $29.3 million, up 4% from the same period last year.

Moving on to EMEA, our EMEA segment reported net sales of $264 million, down 5% in US dollars.

In constant currency, net sales decreased 6%.

Also in constant currency, sales of hardware decreased 4% due primarily to lower sales of servers, notebooks, and desktops.

Software sales decreased 9%, reflecting increased sales to large and mid-market clients more than offset by a decline in the public sector.

Services' sales in EMEA grew 31% in the third quarter.

Gross profit in EMEA decreased 9% in US dollars and 10% in constant currency terms, while gross margin decreased 80 basis points year to year to 14.9%.

A positive effect of higher services' sales was offset by the effect of lower overall product sales volume.

Selling and administrative expenses in EMEA in the third quarter were down 2% in US dollars and 4% in constant currency terms, but the decrease year over year was primarily driven by lower [TMA] costs resulting from recent restructuring activities.

In the third quarter, we recorded net severance expense of $1.9 million in this segment compared to $200,000 of severance benefit recorded in last year's third quarter.

On a non-GAAP basis, our EMEA business reported an operating loss of $1.9 million compared to $1.2 million in earnings last year.

On a GAAP basis, EMEA reported an operating loss of $3.8 million in the third quarter this year compared to $1.4 million of earnings from operations reported in the same period last year.

In APAC, our Asia Pacific operating segment reported net sales of $30 million, down 18% year to year in US dollars and 11% in constant currency terms.

Gross profit was $6 million, down 13% in US dollars and 15% in constant -- and 5% in constant currency.

Our Asia Pacific segment reported earnings from operations of $730,000, down from $950,000 reported a year ago.

With regard to the tax rate, our effective tax rate in the third quarter was 37.8%, lower than the 39% outlook provided on our last conference call due to the [sum] of various discrete items recorded in the quarter.

We expect our effective tax rate to be approximately 39% for the fourth quarter of 2013.

Moving on to our cash flow performance, in the nine months ended September 30, 2013, our operations generated $67 million of cash, up from $30 million last year, reflecting generally lower working capital in the [US] this year.

We also invested $14 million in capital expenditures in the first nine months of this year, down from $22 million in the same period of 2012, reflecting lower IT spending as we have completed our [near] and our North American IT projects.

We spent $50 million on the first half of 2013 to repurchase approximately 2.6 million shares of our common stock.

All of this activity led to a cash balance of $135 million at the end of the third quarter, of which $120 million was resident in our foreign subsidiaries and $88 million of debt outstanding under our debt facilities.

This compares to $141 million of cash and $121 million of debt outstanding at September 30, 2012.

And from a cash flow efficiency perspective, our cash conversion cycle was 31 days in the third quarter of 2012, an increase of one day year to year due to increased inventory balances to support specific client engagements.

One last item before I turn the call over to Ken.

As announced today, our Board of Directors has approved the plan to repurchase up to $50 million of our common stock.

These share repurchases will be made on the open market through block trades or through a 10B51 plan.

We intend to launch the buyback in the fourth quarter subject to market conditions.

I will now turn the call back to Ken.

Thank you Glynis.

Moving on to our outlook for the quarter of 2013, we currently expect diluted earnings per share to be between $0.49 and $0.54 in the fourth quarter.

For the full year 2013, earnings per share is expected [to be] between $1.80 and $1.85.

This outlook includes an effective tax rate of 39% for the fourth quarter.

This outlook excludes severance and restructuring expenses incurred during 2013.

Thank you again for joining us today.

I want to thank our teammates, clients, and partners for their dedication to Insight.

That concludes my comments.

We'll now open the line up for your questions.

(Operator Instructions)

Brian Alexander, Raymond James.

Glynis, maybe could you go over the gross margin improvement again?

In North America, it was up almost 100 basis points, I believe, year over year, and I think you had a lot of factors that you talked about.

It sounded like just a lot of really good blocking and tackling, but I think you alluded to vendor funding and better mix, better software margins.

Maybe if you can just kind of isolate the most important variables, quantify them if you can, but also, what is the sustainability of this gross margin result aside from the software vendor issues that I'll ask about separately?

Is this a level that you can build from or where there's some anomalies that help you with the performance?

I think that in Q3 -- I'm not sure that we'll share the details about composition of the numbers, but I would say there were not anomalies.

We had some spending in software that occurred at the very last -- in the very last days of the quarter that was higher than we had anticipated in EAs that helped us from a Microsoft perspective because that's the vendor that has enterprise agreements.

That's not unusual.

It usually comes from the end of a quarter.

This Q3 was a little bit stronger than normal, but I wouldn't say that's an unusual activity.

We talked in the second quarter call, as well, about increased [SR] related to certain strategic vendors that we had partnered with where we hit some thresholds and, hence, got higher rebate dollars as a result of that.

We were successful again this quarter in terms of driving that activity.

So I think that, in general, I would say when you look at our results for North America -- and I think Ken may have touched on this in his comments -- we think that we're seeing a strengthening in the business.

We had anticipated that we'd see that earlier, but we are starting to see that business.

We talked about in the second quarter call that we saw some strengthening in July, and I'd say that that [bore fruit for us] in the third quarter, albeit that we were still down 1% in total, but that was an improvement from prior years.

So I think we're seeing strengthening on the fundamentals based on the (inaudible) we've put in place, and I wouldn't say that it was a one-off activity.

Okay, great.

And then on the Microsoft issue, I think you quantified it as a $15 million to $20 million gross profit headwind, if I heard that correctly, in 2014, but I think you also alluded to some immediate impacts in the fourth quarter.

So can you quantify what the fourth quarter impact might be and is that 15 to 20 incremental to whatever that might be, or is it inclusive of the Q4 impact?

And do you think there will be any lingering effects beyond 2014 that we should talk about, as well?

Yes, so Brian, so the impact in Q4 will be $2.5 million --

That's included in the guidance.

-- and that's included in the guidance that we provided.

And then, as we mentioned, in 2014 again, calendar year, $15 million to $20 million impact.

And in that is built in the course the remediation programs that we have in place that we think are sort of moderate remediation activities that we believe we can deliver on for that.

As far as beyond 2014, we're not in a position to really give you what that might be as historically we've proven that we've done a reasonable job at remediating so it would be premature for us to tell you what that might be in 2015 and 2016, but some of the programs, as you know, are three-year programs, so there is certainly some impact in 2015 and 2016, but at this stage, I think it would be premature for us to try to put a financial impact on those.

Do you think the actions you're taking, Ken, will just partially offset this lost gross profit, or do you think they can almost entirely offset?

I'm just trying to get a sense for if we look at 2014 if there's modest growth in the overall industry and you're fighting this $15 million to $20 million headwind, what's the likelihood that you could actually grow earnings in that kind of environment?

Yes, so we're projecting at this point, Brian, for 2014 that we'd still be able to -- with these program changes be able to deliver low to mid-single-digit year-over-year earnings growth through 2014.

Okay.

That's EPS growth?

Correct, as well as [EFO].

Okay.

And then final one for me and I'll jump back in the queue.

Just on the sales execution that you highlighted, which sounds like it helped you this quarter, your hardware business in North America was up sequentially, and it sounded like you were fairly confident on bookings patterns quarter to date, which is different than what we've heard from some other competitors and suppliers about just overall demand trends still being a bit difficult.

So if you could just talk about the demand environment in North America specifically and tie in how much of the improvement you've seen do you think is macro, how much is specific to the actions you've taken, and within that, what actions have you taken that you think are really starting to pay off?

Thanks.

Yes, I think we've certainly watched all the reports and so forth and projections for Q4 that are a little bit muted, maybe a little bit more conservative, as you stated.

We believe that we are executing better and that we will have, as we stated, top-line and bottom-line growth in Q4, and a lot of it, I think, is just the programs that we've been executing on this year as far as just the basic sale of execution.

And, of course, as you stated, we've been validating this, of course, through our bookings that we track on a daily basis, as well as where the current trend of the business is now that we're almost through the month of October, as well, so we have certainly a degree of confidence that we'll continue to execute through the quarter.

Okay, thanks a lot.

Can I just clarify one part of Ken's comment?

I think he answered the question for you, Brian, about the incremental impact on the Microsoft program changes in the fourth quarter (inaudible) $2.5 million.

That is correct.

For the [needed] program changes that weren't effective October 1, the total impact of program changes in the fourth quarter is $6 million to $8 million is what we're anticipating for the fourth quarter of 2013.

In total, the combination of the new and the old one is all those [hints of] guidance that we give.

Right, so the incremental is 2.5 in the quarter?

That's correct.

Yes.

And the incremental for 2014 is 15 to 20 above 2013?

Correct.

Got it.

Okay, thanks.

(Operator Instructions)

Nikhil Kumar, Stifel.

This is Nikhil Kumar for Matt Sheerin.

So just want to touch base on EMEA side.

I mean if you can share what steps you are taking to improve the operation and if there is timeline to see the margin improvement in the region?

Yes, Nikhil, this is Ken.

Thank you for the question.

The European business, I think as you've seen from other reports so far, has been (inaudible) from a top-line point of view from the people that we track, so the business environment certainly from a revenue point of view was negative, we think, across the board for IT spending for what we saw for hardware and software.

And we're pretty much in line with that being a minus 6% from all the analysis that we've done, so maybe a little bit worse but pretty much in line with that.

So the actions, of course, that we're taking is to make sure that our operating costs are in line [and with] that make sure we've been doing that throughout the year.

Very important, we're looking at how do we continue to get key drivers going for both the hardware business, the software business.

The services business is executing well over there as we indicated.

That part is growing nicely.

But in the hardware side, definitely opportunities for us to execute better in our UK business, as well as in Germany.

Those two areas represent a big opportunity for us to execute better on the hardware side.

And in the software side, certainly we were navigating some of the program changes that we had thought we [remade] a little bit better in Europe that we didn't in the quarter, so that certainly had a negative impact for us.

To answer your last question, so when do we think that will come back?

As I mentioned in my comments, we think it will take probably a few quarters before we see year-over-year earnings growth in -- for our European business.

Thank you.

And just want to (inaudible).

In the EPS guidance, (inaudible) impact from share repurchase or not?

No, there's no impact from share repurchases.

We don't believe that.

It's too early for us to estimate how much would actually even be done in Q4, so, no, we have nothing in our guidance built in for the share repurchase that we just got authorization for.

Oh, perfect.

Thank you.

Brian Alexander, Raymond James.

I guess maybe a little bit more commentary on product categories within the hardware business that you found to be a little bit better than expected, maybe a little worse than expected, mostly focused on North America but also some color on Europe.

And then I just have one more follow-up.

Yes, Brian, so networking, we did see some nice positive growth in that part of the business, so that was very, very good to see.

The notebook/desktop was relatively flat, down just a slight bit, so that was reasonable, I think, for what we're seeing in the market there.

Certainly, I know there's more pressure on desktops than notebooks overall, but that was reasonable to see.

And then probably the area that we're watching closely is the server market.

Definitely saw -- it's probably a little bit a steeper decline than we certainly would've liked to have seen for the business.

And then we certainly see print continuing to decline, and we're starting to move pretty aggressively towards managed print in that business throughout the year, so we are benefiting from that on the services side, but from the actual traditional print and income toner business, that -- it's definitely (inaudible).

And then I think you said in your prepared comments large enterprise was still relatively weak.

How would you contrast that with SMB?

Would you say SMB was better than expected?

And I'm sure that probably relates a little bit to the sales execution that you have, but just trying to get a sense for whether that market is improving or would you call it stable, and I don't think you have much federal exposure, but any comment on federal?

Yes, we definitely -- we saw the SMB market improve for us, and I think some of that is probably better execution on our side as that is an area that we (inaudible) as greatly as we should've been, so I think we're starting to catch up there.

So we definitely saw some nice activity there in growth.

And you're correct.

On the large enterprise side, still a little bit more conservative, a little bit more muted.

In that regard, they're starting to trend, we think, in a positive direction now on the enterprise side.

On the public sector, we really didn't see much impact from the whole sort of October 1st sort of initiative with the government.

We didn't really see any kind of negative impact there.

As we looked at Q4, there's still some concern about when are new budgets really going to be set in place.

Obviously, I think everybody's confident that that will get done, but I don't think there's any real assurances.

That could get pushed out, so a lot of them are operating, of course, under some of the prior dollars that they have, so that's one that we're watching closely.

How much of your North American business, Ken, remind me, is federal?

(Inaudible - multiple speakers).

Yes, it's like 4% is federal.

Okay, 4%, but are you suggesting it wasn't down materially?

I know some of your suppliers, one of your storage vendors talked about it being down 40%, and I'm just wondering -- it doesn't sound like you saw that kind of precipitous decline.

No, no, not at all.

No, we didn't see that at all.

Okay.

And then the last one, Glynis, on the buyback, I know you didn't necessarily factor it into the EPS guidance for Q4, but I couldn't tell from your earlier comments whether you would start to act on that buyback in Q4, or was that in Q1?

No, we would start to act on the buyback in Q1, but just based on -- I'm sorry, in Q4, in Q4.

But just based on the timing of purchases and the amount and the averaging that occurs with the (inaudible) weighted for the quarter, it's not going to have an impact in Q4.

If all goes well and we execute it on a complete buyback program in the first quarter 2014, we anticipate it will have somewhere in the range of maybe $0.10 impact on our EPS.

That was not included in the range that Ken gave you [when we said] low, low to mid-single-digit growth on a year-over-year basis.

Okay, so the low to mid-single-digit growth is true -- is earnings growth, and then we would have --

It's earnings growth.

-- share buyback on top of that?

Correct.

Great question.

Thank you.

All right.

Thank you.

That's it for me.

(Operator Instructions)

Presenters, at this time, I'm showing no additional questioners in the phone queue.

And with that said, that does conclude our time for questions and answers, and it will also conclude Insight Enterprises' Third Quarter 2013 Earnings Conference Call.

Ladies and gentlemen, thank you for your participation, and have a wonderful day.

You may now all disconnect.